- 1 Why did my stock go up and my call option go down?
- 2 wiseGEEK: What Should I Know About Going over a Credit Card Limit?
- 3 Why was my credit card limit lowered?
- 4 How do you increase your credit limit?
Why did my stock go up and my call option go down?
Have you ever bought an option, watched the trade go in your direction (up for a call, down for a put) and noticed that your option actually went down in price? How could this be?
A few weeks ago two of our students, Jim and Kara, visited our office from way up in Minnesota. Josh and I both happened to have time so we all went to lunch together. During our lunch Kara told me about an interesting situation that she did not understand. She had purchased a call option, the stock had moved about $8-10 in the direction of her trade, but “for some reason my account is down”.
I knew immediately what her problem could be.
There are only a handful of situations that could account for this scenario.
Every option trader “knows” that options run out of time and eventually expire. Unfortunately not every new option trader really knows what this means. Let me put it simply – it means that every day your option premium is going to lose money.
Now it should be noted that only the premium portion of the option is subject to time decay. Intrinsic value is not affected by time decay. It should also be noted that time decays faster the closer you get to expiration.
With these two known factors we can set the trade more in our favor by simply following two rules: 1) buy 1-2 strike prices IN the money and 2) buy 4 weeks more time than we expect to need in the option.
By putting these two boundaries on our trades we remove a good portion of that exposure to time decay. However a lot of traders ignore these boundaries because they take a little more capital.
What often happens is a trader will buy 1-2 strike prices OUT of the money, and hope the trade goes up. But what they find is even though the trade moves, it may not move as fast as time decay. This makes it much more difficult to profit on the option and it creates a scenario where the stock can move in the right direction and the option will still lose value.
In Kara’s situation time decay was not the problem. She still had several weeks left in her option and she was already deep in the money. I went to the next most likely cause.
Scenario #2 – Reduction in Implied Volatility
There is a hidden threat to options that shows up in the form of implied volatility. It is particularly rough during earnings season. If you look at the greeks of your option you will see a couple of interesting values. One is the “IV” or Implied Volatility. The other is Vega.
Implied Volatility is a component of the premium pricing. And for better or worse, it can change rapidly. When Implied Volatility changes, it impacts the option premium by the amount indicated in the Vega column of your option chain.
So if you have a vega of .08 and your volatility goes up by 1 point, your option will increase by .08. If your option volatility goes down by say 10 points, your option price will go down by .80! (.08 x10).
This scenario is very common around earnings season. Here’s what happens. As the stock is getting closer to reporting earnings the option implied volatility is slowly “ramped up”. This accounts for the uncertain nature of the impending earnings release.
Much to the surprise of many option traders, once the earnings announcement is release, the implied volatility returns to normal. This has an immediate negative impact on the option premium.
Consider the recent earnings on NFLX. As soon as earnings were released the IV dropped by 30 points! Considering NFLX has a vega of .47, a 30 point drop in implied volatility represents an immediate $14.10 decrease in the option premium (0.47 vega x 30 points in IV)!
For most stocks the impact of this move does not represent $14.00, however it can be a sizeable percentage of an option premium. Many option traders have fallen victim to the assumption of a great earnings trade only to find they were right on the move, but wrong on the option – all because they failed to understand the impact of volatility.
So I asked Kara if her trade had just gone through earnings and she said no. That left one more logical solution.
When an option moves deep in the money it becomes less attractive to speculators. As a result, there is less volume on the option. This leads the market makers to widen out the Bid/Ask spread. And before you know it, your account balance looks like your option is losing money when in fact it is not. How?
Account balances are based on the “last price” that an instrument actually trades. However, with options that are deep in the money, often times the last trade may have been a long time ago! This makes the last price look drastically different than the current quote.
Consider these DEEP in the money options on QQQ. The stock is trading at $108.88. But here you can see the $84-$88 options still have plenty of open interest, but no volume.
If you look at the “last price” you will notice it is substantially different than your current Bid/Ask.
So imagine you own a few contracts of the $88 call option. You have over $20 of intrinsic value. But the last price is actually less than the current intrinsic value! This will mess up your account balance and lead you to believe that your account is going the wrong way when in fact you were correct in the trade and in fact if you wanted to sell even at a market order, you would have much more profit in the trade than the balance sheet is reflecting.
“Ah-ha!” That was Kara’s problem. She was deep in the money. The last price on her option was showing almost $2.00 below the current bid/ask and as a result it was appearing as though her trade was not going up. In reality she had a great trade and simply needed to enter a limit order to sell, or in a worst case exercise the option and turn around and liquidate the stock position.
What Kara experienced is a very common among new option traders. It is easy to just look at the account balance and assume that it is reflecting all of the current information. However if something looks goofy, dig a little bit to see if maybe the last reported price is different than the current Bid/Ask quotes. If it is, then there’s a good chance that is a component of why your trade price looks wrong.
If you want to understand option pricing more, consider watching our Options Made Simple training or the Mastery class titled “Avoiding Volatility Tax”.
wiseGEEK: What Should I Know About Going over a Credit Card Limit?
Going over a credit card limit can have some unfortunate consequences. It can involve large penalties or extra fines and fees, a transaction could instead be denied, and it may temporarily affect your credit score. Most people worry a lot about this last consequence, but it should be stated that accidentally going over the limit once is not likely to have a long term effect on your credit rating.
Credit card companies have numerous options they can exercise when a person tries to make an over the limit purchase. Usually, if the amount is very small, they won’t deny the purchase. This is especially true if the limit had not been reached prior to the purchase. A large purchase that goes over the credit card limit by a greater amount is likely be handled different.
If a customer has excellent credit, the card company might increase the limit. It is better to call the company and ask for an increase instead of waiting for their response. Alternately, the card company can simply refuse the transaction.
Another tactic is to allow the purchase but to charge extremely high fines. These penalties should be defined in each credit offer. The amount owed on over limit expenses is usually due immediately and customers may be charged a late fee for going over a credit card limit and not paying the overage amount right away. All in all, the combination of penalties and fees may be quite high if you exceed your limit.
Sometimes, credit card companies treat going over the limit as an excuse to raise interest rates. Alternately, they may charge additional interest on any over limit amounts. It’s wise to avoid this practice because of the potential fees involved.
As for your credit rating, the credit reporting agencies tend to evaluate how much credit is available to a person. When someone has $1,000 US Dollars (USD) of available credit and uses $900 USD, there is only 10% available credit. The credit rating reflects negatively when a person uses up most of his or her available credit, and obviously going over a credit card limit will show that the person does not have any available credit.
When a person can immediately rectify this situation, this report changes quickly. The credit report would only reflect this in the month it occurred. Constantly going over your credit card limit will mean this always shows up on your credit report, however. Consumer counselors recommend that consumers use no more than 30% of their available credit to maintain a good credit rating, and this will help keep purchases from exceeding credit limits.
4) "@SurfNturf9quot; - I agree that the department store cards carry very high interest rates. I wanted to say that many banks are also changing the minimum payment percentages because so many people have maxed out their credit cards.
I know that Chase changed its minimum payment from 1% to 2% and some people are even paying 5% of the total balance in some cases. While this may not seem like much if you have a balance of $25,000 those credit card payments can feel like a small mortgage.
Also most of the banks have upped their interest rates for late payers to up to 30% interest. So if you can pay down your debt you are better off because borrowing this money is getting more expensive.
I always look at how long it will take me to pay off the balance and that always keeps me from paying the minimum payment.
3) "@GreenWeaver9quot; - I agree with you. This is why a lot of department stores always try to get you to open an account and offer you additional savings on your current purchases if you do.
They know that once you open the account you will more than likely buy more than you would have if you were paying cash and they earn about 24% in interest payments for those customers that carry balances.
The department store credit card APR is among the highest of all the credit cards out there. I do have a Macy’s account, but I only use it a few times a year and then I pay it off right away. I only use during Black Friday when the incentives are huge.
2) "@Cafe419quot; -I agree with you especially if something like this happens in mixed company. I wanted to say that when I had a student credit card in college, I found myself carrying a balance way beyond college and ended up maxing out my credit cards.
In fact my credit card balance was $9,000 which is when I had enough and paid down my credit card bill, and I now use my credit card sparingly and pay off my bills at the end of the month when I do.
I think that another good strategy to avoid overspending involves developing a budget and allocating a certain amount of money in cash for each category and placing the cash in the envelope.
This way if you designate your clothing allowance to be $200 for the month, once the envelope is empty you are done for that month.
This will force you to spend what you can afford to spend. There are many studies that show that when you use your bank credit card or any credit card for that matter you will tend to spend more because you are not held immediately accountable for your purchases as you are when you pay cash.
I always try to pay my credit card bill at the end of the month. I used run up balances but when you start to do that it can easy to get carried away and then you have a huge set of bills to pay that can overwhelm you.
It is also embarrassing if you are told that your credit card was declined because you were over your limit. This happened to a friend of mine and I was embarrassed for her.
The additional charges for exceeding your credit limit don't help either. It is really a bad situation all the way around.
Why was my credit card limit lowered?
You pay your bills on time. So why did the credit card company lower the limit?
By Trent Hamm , Guest blogger March 8, 2010
Jennifer writes in:
Yesterday, I received a notice from [my credit card company] that my credit limit had been lowered from $10,000 to $4,000 on my primary credit card. I was immediately worried that my credit had been damaged by identity theft, so I checked it on annualcreditreport.com and there was nothing there at all. I’ve always paid all of my bills on time and my life has been pretty much normal and unchanged for a long time. Why would they make this change? I’m not concerned about reaching my credit limit, but that reduction in my limit does alter my debt-to-credit ratio, which could negatively impact my credit rating.
Jennifer describes a pretty typical scenario today. A credit card company sends a letter out of nowhere, for no obvious reason, announcing a significant drop in one’s credit limit.
One big effect that such a drop has is that it alters your debt-to-credit ratio, as Jennifer mentions. Simply put, your debt-to-credit ratio tells what percentage of your credit limit across all of your credit cards you’re actually using. So, let’s say Jennifer had a $3,000 balance on her $10,000 card – that’s a 30% debt-to-credit ratio. When the company drops her credit limit, she then had a $3,000 balance on a $4,000 card – that’s a 75% debt-to-credit ratio. The higher your debt-to-credit ratio, the more negative impact it has on your credit score.
This type of behavior seems alien, particularly after a decade where credit card issuers would commonly raise credit limits without you even asking. What gives?
The reality of the credit card industry has changed. For one, the econmic downturn has seen a large spike in the number of people who have simply defaulted on their credit card bills, not bothering to pay them. For another, the Credit Cardholders’ Bill of Right Act recently became the law of the land, restricting some of the business practices of the credit card companies.
Credit limits are not a right. Another issue is that many people, particularly after the last decade of rampant growth in credit limits, view their limits as something of a right and when credit card companies reduce those limits, their rights are somehow being infringed. In truth, that’s not the case at all – your cardholder agreement makes it very clear that your credit limit and your interest rate can be changed at any time.
So how do they decide when to lower your limit?
They watch what you buy via data mining. Every time you make a credit card purchase, the credit card issuer’s computers store a record of that purchase (you’ll see such information on your bill). Obviously, this is a wealth of information, one that they can use to figure out all sorts of things, such as where you live (so that if you suddenly make a rash of purchases elsewhere, they can throw a block on the card).
They draw conclusions based on what you buy. Another thing that they do is watch what you buy. They look at the places you normally shop and draw conclusions based on that.
Let’s say Jennifer normally shops for clothing at, say, Banana Republic (I don’t know this, I’m just creating a hypothetical example). Based on this, the credit card company would conclude that she fits the profile of an average Banana Republic customer, meaning she has a fair amount of discretionary income.
Now, let’s say Jennifer is suddenly a bit worried about the economy. She and her husband decide to curb their spending and she starts doing things like buying soap at the dollar store with her credit card.
When the credit card company analyzes the data, looking for spending changes that might affect credit limits, they’ll observe from their data that Jennifer is spending a lot less at the Banana Republic and a lot more at the dollar store. That means she’s got a different spending profile – one that signifies the potential for financial trouble.
They act in accordance to those conclusions. Given their recent problems with people defaulting on credit card debt, they take pre-emptive action and reduce her credit limit.
To Jennifer, this seems sudden and unfair – and for good reason. She’s likely not in any true financial trouble at all and is simply choosing to be a bit thrifty in these uncertain times.
What can you do to protect yourself? The truth is that Jennifer should avoid being in any kind of position where such a credit limit change has any impact at all on her. In other words, don’t be reliant on that piece of plastic. Use it as a tool instead of as something you need to have.
One big way to do that is to never carry a balance on your card. If a bill comes at the end of the month, pay it off. If you’re thinking of making a purchase where you wouldn’t be able to do that, you can’t afford that purchase. Wait a few months and save up the cash.
This not only keeps your debt-to-credit ratio pretty low, but it also leaves you out of any sort of “danger” from the credit card company adjusting your limits or your interest rates. More importantly, though, it prevents you from building up a significant amount of debt on the card, which can be very, very difficult to pay off.
Use your credit cards wisely and changes like what happened to Jennifer will have little or no impact on your life.
The Christian Science Monitor has assembled a diverse group of the best economy-related bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. To add or view a comment on a guest blog, please go to the blogger's own site by clicking on the link above.
How do you increase your credit limit?
If you have a credit card or overdraft but want to increase your credit limit, how can you go about it? This guide looks at what you can do to increase your limit and, more importantly, whether or not you should.
This is the maximum amount you can spend up to on a credit card or overdraft.
When you apply for a credit card, you won’t usually know what the credit limit will be, although you might be told the maximum for new customers.
Often, you will only be notified of your actual credit limit when you receive your new card.
That can be a real problem in some cases.
For example, if you want to transfer an existing balance, to take advantage of a 0% deal, but your new credit limit is too small to do so, you might be disappointed.
If this matters, ask the card provider before you apply, and before you sign the credit agreement.
The card provider should be able to give you an idea of how much you are likely to be offered, although they might need to do a credit check first, to make sure that you’re eligible and can afford to repay that amount.
If you’re shopping around and not yet ready to apply, make that clear so a mark isn’t left on your credit file.
If you aren’t happy with your credit limit, you can request a higher limit from the credit card provider.
However, it is a good idea to wait for several months first so that the lender can see that you’re a sensible customer.
Of course, if you exceed your existing limit on your card or miss any payments, the card providers is unlikely to agree.
Not only that, but you’ll damage your credit rating, which might stop you getting a better credit deal elsewhere.
The card provider might offer you a higher credit limit, once you’ve been with them for a while.
You don’t have to accept this - you can reject the proposed increase (or ask for a smaller increase), and you can also make it clear that you don’t want to be offered any future increases - for example because you’re worried you might be tempted to over spend.
If you decide you don’t want an increase, let the card provider know - they should make it easy for you to opt out.
If you want your lender to increase the amount you can borrow, you need to be as creditworthy as possible.
They won’t give you a higher limit if they think you can’t afford it or are likely to default.
Lenders usually decide whether or not you’re a suitable customer by looking at your credit reference file, as well as making other checks.
They will take into account how well you’ve managed your existing credit commitments.
But before you take any steps to increase the amount you can borrow, you need to be sure it’s right for you.
Increasing your credit limit – Can you afford it?
Whenever you’re considering increasing your debt, it’s essential you work out a repayment plan that you can afford first.
Check the articles below for more information:
If you want to increase your authorised overdraft limit then it can be tempting to simply keep spending.
But that is a really bad idea. Even if the bank allows you to spend beyond your overdraft limit, you’re likely to be charged high fees for doing so (much higher than for an authorised overdraft).
In other cases, the bank might refuse to pay but charge you an ‘unpaid item’ fee.
In either case you risk damaging your credit rating.
Should you increase your credit limit?
It’s worth thinking about why you want to increase the amount you can borrow.
There could be some perfectly sensible reasons but it also might be a warning sign that you aren’t handling your debt well.
When to consider increasing your credit limit
For example, maybe you use your credit card to pay for work-related expenses before claiming them back.
If your expenses suddenly grew then it might be a good idea to increase your credit limit to avoid a cash-flow problem.
If you regularly pay your credit card bill in full each month and have a solid income stream, the bank or card provider might agree to the increase, if it’s not too much.
When not to increase your credit limit
However, perhaps you want to increase your credit limit because you’re struggling to meet all your expenses, including repayments.
If that’s the case then increasing your credit limit isn’t the best idea as you’re really only adding to the problem.
If that’s the case, it’s important to act as soon as possible to stop yourself getting into levels of debt you can’t pay off.
You could speak to a free debt adviser, or ask the card provider to reduce your credit limit, if you’re worried about over-spending.
If you can’t increase your credit limit then you might be tempted to turn to expensive, short-term lending.
In many cases borrowing at a high rate of interest just delays and worsens the problem and so should be avoided if possible.
Increasing your credit limit – Is it a bad idea?
Even if you’re not at risk of taking on too much debt, increasing your credit limit might not be the best thing to do.
It will increase the temptation to take on more debt than you otherwise would.
It can also stop you qualifying for other, more important lending like a mortgage.
That’s because lenders often look at the amount of credit you have access to when they are deciding whether or not to lend to you.
Even if your credit card isn’t up to its limit, simply having a high credit limit might put other lenders off.
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